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TIR 87-13: Short Taxable Years for Partnerships, S Corporations, and Personal Service Corporations

INTRODUCTION

The federal Tax Reform Act of 1986 ("TRA") generally requires that all partnerships conform their taxable year to the taxable year of the partners or the calendar year and that S corporations and personal service corporations conform their taxable year to the calendar year. See TRA § 806. Internal Revenue Code ("IRC") §§ 441(i), 706(b), 1378 (1986). Seealso Rev. Proc. 87-32, 1987-28 IRB 14. As a result of this change many partnerships, S corporations, and personal service corporations that have been filing on a fiscal year basis must now adopt a calendar year. Most entities in Massachusetts affected by these provisions will also change from a fiscal year to a calendar year for Massachusetts tax purposes. The purpose of this Technical Information Release is to explain the Massachusetts tax results of these changes required by TRA § 806: how partnerships, S corporations, and personal service corporations in Massachusetts will change from a fiscal year to a calendar year for Massachusetts purposes and how this change will affect the partners and shareholders of these entities.

FEDERAL RULES ON CHANGE IN TAXABLE YEAR

The Tax Reform Act of 1986 requires new and preexisting partnerships to adopt or change to, in order of priority, the taxable year of the partners owning the majority of the partnership interests, the taxable year of all principal partners, or the calendar year. The Act also requires S corporations and personal service corporations to use the calendar year. TRA § 806; IRC §§ 441(i), 706(b), 1378 (1986). One exception to this provision is where the entity successfully establishes a business purpose for a different taxable year, see TRA § 806; IRC §§ 441(i)(1), 706(b)(1)(C); 1378(b)(2).

Section 806 of the Tax Reform Act applies to taxable years beginning after December 31, 1986. The entities affected by the provision will complete their last fiscal year in calendar year 1987 and will then have a short taxable year ending on December 31, 1987. These entities are to be treated for federal tax purposes as having made the change with the consent of the Secretary of the Treasury. TRA § 806(e)(2). A partner or S corporation shareholder who would otherwise be required to include items of income from more than one taxable year of the entity may take into account the excess of income over expenses for the short taxable year of the entity in the partner's or shareholder's first four taxable years beginning after December 31, 1986, unless the partner or S corporation shareholder elects to include all the income in the partner's or shareholder's taxable year in which the entity's short taxable year ends. Id. Personal service corporations are under a different rule: they should annualize the income in the short taxable year as provided in IRC § 443(b). IRC § 443(b) (1986).

MASSACHUSETTSRULES ON CHANGE IN TAXABLE YEAR

In Massachusetts four types of entities are affected by the provisions of TRA § 806: partnerships, S corporations, [1] corporate trusts that are also S corporations ("corporate trusts"), [2] and personal service corporations ("PSCs"). The taxation of partners, S corporation shareholders, and corporate trusts is governed by chapter 62 of the General Laws. See G.L. c. 62, §§ 8, 17, 17A. The taxation of corporations, including S corporations and PSCs, is governed by Chapter 63 of the General Laws. See G.L. c. 63, §§ 30-42B. If the partner or shareholder of an entity is an individual, trust, or estate, the income of the partner or shareholder is taxed under Chapter 62. If the partner or shareholder of an entity is a corporation, the income of the partner or shareholder is taxed under Chapter 63.

Partnerships and Corporate Trusts

Under Chapter 62, a "`taxable year' shall have the same meaning as in the Code, except as otherwise provided in section sixty-two of [Chapter 62]." G.L. c. 62, § 1(h). The Code is defined as "the Internal Revenue Code of the United States, as amended on January first, nineteen hundred and eighty-five and in effect for the taxable year." The 1985 Code defines a taxable year as: "(1) the taxpayer's annual accounting period, if it is a calendar year or a fiscal year; (2) the calendar year, if [IRC § 441(g) on No Books Kept; No Accounting Period] applies; [or] (3) the period for which the return is made, if a return is made for a period of less than 12 months. . . ." Section 62 of Chapter 62 provides that "the period for which income is to be computed shall be on the basis of a calendar year unless a taxpayer actually keeps his books of account on the basis of a fiscal year and has obtained permission from the commissioner to report his income on such a basis."

To request permission from the Massachusetts Commissioner of Revenue to file on a fiscal year basis, taxpayers governed by Chapter 62 ordinarily would file DOR Form 13, Notice of Designation of Fiscal Year. Upon approval by the Commissioner, the taxpayer may file on a fiscal year basis. Generally, once a taxpayer has adopted a fiscal year, the taxpayer must continue to file on a fiscal year basis, until the Commissioner approves a return to the calendar year or a different fiscal year.

Partnerships and corporate trusts required by TRA § 806 to change their federal taxable year to a calendar year should change their Massachusetts taxable year by filing the appropriate returns for the period beginning on the day after the end of the taxpayer's usual fiscal year and ending on December 31, 1987. These entities are not required to file DOR Form 13 to request the change, and permission to file on a calendar year basis will be deemed to have been granted upon the filing of the short taxable year return. When filing their returns, partnerships and corporate trusts should add at the top of the short taxable year return, "Filed in compliance with TIR 87-13." This procedure applies only to short taxable years ending December 31, 1987.

S Corporations and PSCS

Most corporations are taxed under section 30-42B of Chapter 63. A taxable year is defined as "any fiscal or calendar year or period for which the corporation is required to make a return to the federal government." G.L. c. 63, § 30, cl. 6; seealso G.L. c. 63, §§ 1, 52A. The Massachusetts Department of Revenue requires written notification from the taxpayer, preferably on DOR Form 13, Notice of Designation of Fiscal Year, of any change in taxable year.

The S corporations and PSCs required under TRA § 806 to change their federal taxable year to a calendar year and who also change their Massachusetts taxable year should do so by filing the appropriate returns for the period beginning on the day after the end of the taxpayer's usual fiscal year and ending on December 31, 1987. Notification to the Massachusetts Department of Revenue will be deemed to occur upon the filing of the short taxable year return. When filing their returns, taxpayers should add at the top of the returns for the short taxable year, "Filed in compliance with TIR 87-13." This procedure applies only to short taxable years ending December 31, 1987.

Corporations taxed under sections 30-42B of chapter 63, including S corporations and PSCs, must pay the greater of two excises: a minimum excise of $228 for each taxable year; or an excise based on a percentage of the value of the corporation's tangible property or net worth and a percentage of the corporation's net income. See G.L. c. 63, §§ 31B, 32, 39; St. 1969, c. 546, § 18; seealso 830 CMR 62.17A(3), (4). For corporations which pay the $228 minimum excise tax, chapter 63 permits no proration of that amount for taxable years of less than twelve calendar months. See G.L. c. 63, §§ 32, 39. For corporations which pay the second excise, sections 32 and 39 of chapter 63 provide that the tangible property or net worth measure of the excise is multiplied by the number of months in the short taxable year and then divided by twelve. See G.L. c. 63, §§ 32(a), 39(a).

MASSACHUSETTSRULES ON ADJUSTMENTS FOR CHANGE IN TAXABLE YEAR

TRA § 806 permits the partners and S corporation shareholders who would otherwise be required to report in a single taxable year income from more than one taxable year of the partnership or S corporation to take into account the excess of income over expenses in the entity's short taxable year in the partners' or shareholders' first four taxable years beginning after December 31, 1986, spreading the income over four taxable years. Partners and shareholders of Mass. S corporations and of corporate trusts that are also Mass. S corporations ("Mass. S corporation shareholders") will be allowed to spread the income from the partnership's or Mass. S corporation's short taxable year over the four taxable years beginning after December 31, 1986. Taxpayers taxed under chapter 62 as well as under chapter 63 may use the four-year spread. Shareholders of federal S corporations and corporate trusts that are also federal S corporations ("federal S corporation shareholders") that have temporarily elected not to be treated as Mass. S corporations may not use the four-year spread.

Chapter 62 Taxpayers

Chapter 62 of the General Laws imposes a tax on the taxable income of individuals, estates, and trusts. Massachusetts gross income is federal gross income, as defined under the 1985 Code and in effect for the taxable year. See G.L. c. 62,§§ 1(c), (d), 2(a). Massachusetts taxable income is Massachusetts gross income with certain modifications not relevant to this Technical Information Release.

Under Section 62 of chapter 62 of the General Laws the Commissioner must consent to any change in taxable year: "any taxpayer who changes the method of accounting regularly employed by him in keeping his books shall not be permitted to report his income on a method different from that used for the preceding year without obtaining the consent of the commissioner." G.L. c. 62, § 62. To consent to a change in a taxpayer's Massachusetts taxable year, the Commissioner may adopt the terms, conditions, and adjustments under which the change of Massachusetts taxable year occurs, including the terms affecting partners and shareholders.

The one-time four-year spread provision of TRA § 806 is an accounting period rule. It is a term and condition of the change in Massachusetts taxable year, adopted to prevent the distortion of income of partners and Mass. S corporation shareholders. If a partner or Mass. S corporation shareholder uses the four-year spread in reporting that partner's federal gross income for the partner's or shareholder's four taxable years beginning after December 31, 1986, the partners or shareholder must also adopt the four-year spread in reporting Massachusetts gross income. If the partner or shareholder reports all federal income in the partner's or shareholder's taxable year in which the partnership's or S corporation's short taxable year ends, the partner or shareholder must also include all Massachusetts income in the partner's or shareholder's taxable year in which the entity's short taxable year ends.

Federal S corporations and corporate trusts that are also federal S corporations that have temporarily elected not to be treated as Mass. S corporations are taxed on their income at the entity level. The federal S corporation shareholders do not report their distributive shares of the income of the entity and only report dividends or distributions. See 830 CMR 62.17A(4). Federal S corporation shareholders should experience no bunching of Massachusetts income and may not use the four-year spread on their Massachusetts returns.

Chapter 63 Taxpayers

Chapter 63 of the General Laws imposes an excise on business, research and development, and manufacturing corporations, measured in party by the corporation's net income. Net income is defined as "gross income less the deductions, but not credits, allowable under the provisions of the Federal Internal Code, as amended and in effect for the taxable year." G.L. c. 63, § 30, cl. 5(b). Gross income is "gross income as defined under the provisions of the Federal Internal Revenue Code, as amended and in effect for the taxable year. . . ." G.L. c. 63, § 30, cl. 5(a). Unlike chapter 62, chapter 63 incorporates the current Code.

The four-year spread provision is an accounting period rule and is a term or condition of a change in Massachusetts taxable year. If a partner that is a corporation taxed under chapter 63 uses the four-year spread in reporting its federal gross income for the partner's four taxable years beginning after December 31, 1986, the partner must also adopt the four-year spread in reporting Massachusetts gross income. If the partner elects to include all federal gross income from the partnership's short taxable year in the partner's taxable year in which the partnership's short taxable year ends, the partner must also include all Massachusetts gross income in the same taxable year.

/s/Stephen W. Kidder Stephen W. Kidder Commissioner of Revenue

December 17, 1987

TIR 87-13

[1] For purposes of this TIR, an S corporation is different from the definition in 830 CMR 62.17A(2). Under the regulation, S corporations may be corporations or corporate trusts. In this TIR we distinguish between S corporations that are corporations and S corporations that are corporate trusts. We do, however, use the regulation's definition of shareholder, which includes both shareholders of S corporations and beneficiaries of corporate trusts that are S corporations.

[2] Corporate trusts that do not meet the federal requirements for S corporation status are taxed as associations and are under the general federal provisions regarding the taxation of corporations. This TIR does not address that type of Massachusetts corporate trust. See TIR 87-8 for a discussion of short taxable years for trusts.

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